Citation: 2004TCC256
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Date: 20040402
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Docket: 2000-5000(IT)G
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BETWEEN:
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PANTORAMA INDUSTRIES INC.,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Paris, J.
[1] The Appellant is a public company
that operates several chains of clothing stores in Canada under
such names as Pantorama, Levi's, 1850 and D'Gala. Its
headquarters are in Montreal and its stores are located primarily
in leased premises in shopping malls. Since 1979, the Appellant
has engaged another company, Snowcap Investments Ltd., to find
new locations for its stores and to negotiate leases and renewals
of leases on its behalf. It paid Snowcap a monthly fee of $2,500
and set amounts for each new lease or renewal that it
arranged.
[2] The Appellant treated the payments
to Snowcap as a current expense of its business. The Minister,
however, took the view that those fees paid in respect of new
leases and renewals were payments on account of capital and
reassessed the Appellant for its 1995 to 1998 taxation years to
disallow the deduction of the fees in the calculation of its
business income. Those amounts[1] were added to the capital cost of the
Appellant's leases and capital cost allowance was allowed.
The Appellant is appealing those reassessments.
Facts
[3] The facts of this case are largely
undisputed.
[4] Mr. Ralph Fragomene, the
Appellant's vice-president in charge of finance and
operations, explained the circumstances surrounding the payments
made to Snowcap. The original agreement between the
Appellant and Snowcap ran for three years, and was renewed every
few years. It provided that Snowcap was to act as Appellant's
consultant and advisor for the establishment of all of its retail
locations with certain limited exceptions. The Appellant agreed
not to engage any other real estate consultants, advisors or
leasing agents to act in a similar capacity and Snowcap agreed
not to work for anyone in the same business as the
Appellant. Although it was not set out in the original
agreement, it is clear from the evidence that the Appellant also
used Snowcap to negotiate the terms of its new leases and its
lease renewals.
[5] In addition to the set monthly
amount, the Appellant paid Snowcap a fee for each new lease and
each lease renewal that it arranged, and for arranging to convert
one of the Appellant's stores to another one on the same
premises. (For example, if the Appellant wanted to convert a
Levi's store to an 1850 store on the same premises, Snowcap
would negotiate this arrangement with the landlord.) Payment was
generally based on the size of the premises involved and, for
renewals, on the length of the renewal. The fees became payable
only upon a binding agreement being entered into between the
Appellant and the landlord.
[6] Mr. Fragomene said that, in the
years under appeal, the Appellant carried on business in several
provinces, although most of its stores were located in Ontario
and Quebec. The Appellant had 233 stores in 1995, 222 stores in
1996, 212 stores in 1997 and 199 stores in 1998, all of which
were operated in leased premises. From 1995 to 1998 the Appellant
opened 46 new stores and closed about 80 stores. It also renewed
between 25 and 30 of its leases each year. The majority of the
new leases that were entered into had a term of between five and
seven years, and the renewals ran from one year to seven years,
depending on how the particular location was performing. The
total rent paid on its stores was approximately $20 million
annually.
[7] Mr. Fragomene referred to Snowcap
as a "retail store advisor" to the Appellant. He said
that Snowcap was responsible for finding suitable rental space
for the Appellant's new stores. Snowcap also provided
advice to assist the Appellant in deciding whether it wanted to
open a store in a particular new location. With respect to
renewals, the Appellant's in-house lease administrator
tracked upcoming lease expiry dates and gave a list of them to
Snowcap. In the case of both new leases and renewals, Snowcap
provided the Appellant with market information and rental rates
and contacted the landlord to establish what terms the landlord
was seeking. Snowcap would act on the Appellant's behalf to
negotiate the terms of the leases and renewals with the
landlords. Upon reaching a deal, it would prepare a letter of
understanding to be signed by the Appellant and the landlord, and
a formal lease would subsequently be drawn up by the
Appellant's lawyers.
[8] Mr. Fragomene explained that the
Appellant hired Snowcap to save time. Given the volume of new
leases and lease renewals in the Appellant's business it
would have taken a lot of his time on a daily basis if he had
dealt with landlords directly. He also said that Snowcap was able
to obtain the best rental rates on behalf of the Appellant
because it acted for so many clients.
[9] When asked about the two different
types of fees (monthly and lease specific) that the Appellant
paid to Snowcap, Mr. Fragomene said that there was no distinction
that could be drawn in terms of the services that it received. He
said all of Snowcap's efforts went to finding new leases for
the Appellant and that there was "no rhyme or reason"
to there being two types of charges. However, in
cross-examination he agreed that Snowcap charged the
Appellant according to the fee schedule they had agreed to for
the specific leasing services provided by Snowcap.
[10] Mr. Seymour Obrant, chairman of
Snowcap, also gave evidence on behalf of the Appellant. He
described Snowcap as a retail leasing consultant whose business
consisted of negotiating shopping mall store leases and renewals
for clients, and resolving any conflicts they had with the
landlords. In essence, he said, it acted as a real estate
department for its clients.
[11] In the years under appeal Snowcap had
about 80 clients of which the Appellant was one of the
largest. Snowcap's sizable client base gave it the
potential to lease up to 150,000 square feet of space in a mall
and allowed it to obtain more favourable rents on their behalf.
Mr. Obrant said that there were about 20 landlords of large
shopping malls in Canada, and that Snowcap saved clients the time
of having to deal with all of them.
[12] Snowcap representatives talked on the
phone daily with the Appellant's management and met with them
once a month to review ongoing leasing matters. Twice, yearly
meetings were held to review the Appellant's plans for new
locations and for renewals of existing locations and to develop a
strategic plan for the Appellant's growth. Because of
Snowcap's involvement in the retail property market, it was
aware of new property developments coming available 4 to 5 years
in the future and could pass this information on to the Appellant
for its consideration.
[13] Mr. Obrant said that the monthly fee
charged to the Appellant was originally intended to cover part of
Snowcap's overhead. Snowcap charges a monthly fee to its
larger clients to ensure cash flow, to pay for travel and to help
with staffing and service. He did not indicate whether the
monthly fee entitled the Appellant to services over and above
those provided on a fee specific basis.
[14] Ms. Anne McCarel, the Appellant's
external auditor from BDO Dunwoody, gave evidence of how the
payments to Snowcap were accounted for by the Appellant. She
stated that she treated the Snowcap fees as a current expense
because in her view they were incurred as part of the
Appellant's ongoing revenue earning operations. The store
leases were considered to be operating leases as opposed to
capital leases for accounting purposes. She explained that, under
generally accepted accounting principles, capital leases are ones
that transfer substantially all risks and benefits of ownership
to the lessee and are treated as the acquisition of an asset on
the books of the lessee.
Issue
[15] The issue in this appeal is whether the
fees paid by the Appellant to Snowcap are deductible as current
expenses or whether they were incurred on account of capital.
[16] Counsel for the Appellant submitted
that the payments to Snowcap were not on capital account because
the leases to which the payments related were not capital assets
to the Appellant. He said that the leases, having terms of seven
years or less, did not provide an enduring benefit to the
Appellant; they were not a long-term asset. The leases were
entered into to permit the Appellant to carry on business on a
daily basis. Furthermore, the leases were recurring. The
Appellant was constantly negotiating new leases and renewals of
existing leases, entering into between 40 and 60 per year. Also,
he suggested that the tax treatment of the leases and the
payments related to them should follow generally accepted
accounting principles under which the leases were not treated as
capital assets. Finally, he said that, even if the leases were
capital property of the Appellant, the payments were not
necessarily on capital account, and that the same factors, such
as duration of the benefit received, recurrence and reason for
the payments should be considered.
[17] Counsel for the Appellant referred to
the Supreme Court of Canada decision in Johns-Manville Canada
Inc. v. Her Majesty the Queen[2] where certain expenses relating to
the purchase of land in the course of the taxpayer's mining
operation were found to have been on income account. He likened
the payments in issue here to those in the Johns-Manville
case on the basis that the payments here did not result in the
acquisition of a capital asset, that the expenditures were
incurred every year as an integral part of the Appellant's
operations, that they formed part of the daily and annual cost of
production, that the benefit was not long lasting because similar
expenditures would be required every year, and the operations of
the Appellant could not continue in the future without these
annual expenditures.
Analysis
[18] The Minister has disallowed the
deduction of the amounts in issue pursuant to paragraph
18(1)(b) of the Income Tax Act[3], which reads:
18(1) In computing the income of a taxpayer from a business or
property no deduction shall be made in respect of
(b) an outlay, loss or replacement of capital, a payment on
account of capital or an allowance in respect of depreciation,
obsolescence or depletion except as expressly permitted by this
Part;
[19] It has been noted on many occasions
that the phrase "outlay or expenditure on account of
capital" is not defined in the Act. In this respect,
the Supreme Court of Canada has said:
There being no statutory criterion, the application or
non-application of these expressions to any particular
expenditures must depend upon the facts of the particular
case.
[20] The usual test for determining whether
a payment is on capital account has been held to be whether it
was made "with a view of bringing into existence an advantage for
the enduring benefit of the appellant's business".[4]
[21] The distinction between payments made
by a taxpayer on capital and income account has also been said to
correspond "to the distinction between the acquisition of
the means of production and the use of them; between establishing
or extending a business organization and carrying on the
business; between the implements employed in work and the regular
performance of the work in which they are employed; between an
enterprise itself and the sustained effort of those engaged in
it."[5]
[22] Put another way:
an expenditure for the acquisition or creation of a business
entity, structure or organization, for the earning of profit, or
for an addition to such an entity, structure or organization, is
an expenditure on account of capital, and ...an expenditure in
the process of operation of a profit-making entity, structure or
organization is an expenditure on revenue account.[6]
[23] The question of whether payment of
professional fees incurred by a taxpayer was on income or capital
account arose in Rona Inc. v. The Queen[7]. In that case,
Archambault, J. said at p. 989:
... The nature of the fees depends on the purpose of the
services that were rendered. If the professional fees involve
current transactions, they are income expenditures. If the fees
involve the expansion of the business structure, they are capital
outlays. For example, if fees are paid for negotiations with
respect to a marketing campaign, they are income expenses.
However, if fees are paid in order to acquire a competitor, they
are capital outlays. What needed to be determined first is the
nature of the transactions conducted by Rona in order to
characterize the nature of the professional services required for
these. Here, the professional services were retained for
transactions in which franchised stores, or "corporate"
stores to be constructed or already owned by competitors were to
be acquired. The purpose of these services was to confer on Rona
an advantage [Translation] "for the lasting benefit of [its]
business."
[24] In applying these principles to this
case the first question to ask is: what was the purpose of the
expenditures, in the context of the Appellant's business? Was
it to obtain new leases and renewals, or to receive real estate
advice and general services including negotiation of leases?
[25] Although there was some suggestion that
the Snowcap fees were for on-going consultations and advice
provided to the Appellant, more in the nature of day-to-day
management type services and not related to specific leases, I am
not satisfied that this was the case. The evidence was clear that
the payments in issue were all made for Snowcap arranging new
leases or lease renewals or for similar services for the
Appellant, and were made according to the fee schedule to which
the parties had agreed. Snowcap was only entitled to receive the
payments once lease agreements or renewals were signed.
[26] While the evidence indicated that
Snowcap assisted the Appellant in the development of its leasing
strategy and with planning, which would be part of day- to-day
management functions, these services were ancillary and
subordinate to its main activity of negotiating leases. The bulk
of Snowcap's efforts were focused on producing new leases and
renewals and I find that the payments were made for that purpose.
It is also reasonable to infer that the monthly payments made by
the Appellant covered the general advice and planning assistance
provided by Snowcap.
[27] The Appellant's counsel argued that
the decision in Rona could be distinguished on the basis
that the Appellant here was not embarking on an expansion
program. I am not convinced that this distinction is valid. I
agree with counsel for the Respondent that the new leases and
renewals did amount to an expansion of the Appellant's
business structure. They resulted in new premises from which it
could sell clothing, or an extension of its right to sell
clothing from a particular location that would otherwise have had
to be closed if the lease had expired. The evidence also showed
that, in the years under appeal, the Appellant had a strategy for
opening new locations in order to grow its business.
[28] It is clear that the leases were part
of the structure of the Appellant's business which permitted
it to carry on its daily commercial activity and to earn its
income. They were part of the Appellant's means of
production. The payments made by the Appellant in relation to
bringing new leases into existence or extending existing ones
pertained to that business structure.
[29] The leases here also provided an
enduring benefit to the Appellant. The terms of the new leases
here were from five to seven years. Also, it may be inferred from
the number of lease renewals that the Appellant executed each
year that it had a certain expectation that its leases would be
renewed, presuming adequate sales were achieved in that
location.
[30] It is true that the payments to Snowcap
were recurrent through the years under appeal, but this does not
necessarily mean that they were expenses on current account. The
overriding purpose of the expenditures was to expand the
Appellant's business by entering into new leases and by
extending expiring ones, and the fact that this was accomplished
many times in a given period does not make the benefit acquired
in respect of each new lease any less enduring. Each renewal was
for a different location, and the frequency of the renewals was a
function of the total number of leases that the Appellant had.
Each payment to Snowcap was a one-time payment in relation to the
particular lease or renewal and the duration of the benefit the
Appellant received was equal to the length of the lease or
renewal.
[31] I do not see the leases in this case as
similar in nature to the land that was purchased in the
Johns-Manville case. There, the Court found that the land
was not part of structure of the taxpayer's mining operation
and the land was consumed in the course of production. The
expenditures on the land were held to relate more to the daily
production of the mine than to the structure and not to provide
any benefit beyond the year in which they were made. In the case
before me the leases were not consumed in any way analogous to
the land in Johns-Manville and the Appellant enjoyed the
benefit of the new leases and renewals over the entire life of
the leases.
[32] The fact that the Appellant treated the
payments to Snowcap as current expenses in its financial
statements is not relevant to the determination of their
character for the purposes of the Income Tax Act. The
question of whether the payments are on capital or income account
is one of mixed fact and law, and the principles that must be
applied to the determination are priniciples of law and not those
of accounting. Even if I had decided that I should consider
accounting principles in arriving at my decision, there is no
expert evidence in this case as to what those principles
are. Although Ms. McCarel told the Court how the payments
were treated in the Appellants books, she was not presented or
qualified as an expert.
[33] The Appellant's counsel urged me to
accept Ms. McCarel's testimony as evidence of the applicable
generally accepted accounting priniciples, and referred me to the
case of R. v. Graat[8], in which a non-expert witness was permitted to give
opinion evidence. This case is not applicable because it does not
deal with expert evidence. Expert evidence is treated differently
than opinion evidence given by a non-expert and is only
admissible where the subject matter calls for expertise, where
the expert is qualified and where procedural requirements
relating to introduction of expert evidence have been met. The
latter two conditions have not been met in this case.
[34] After considering all of the
circumstances of this case and in particular the purpose of the
payments and the benefit received by the Appellant as a result of
them, I am satisfied that the fees paid by the Appellant to
Snowcap were on capital account.
[35] The appeal is therefore dismissed, with
costs. The parties agreed at the hearing that the applicable
class of proceedings for the purpose of determining costs is
Class B because the amount in issue is less than $150,000.
Signed at Ottawa, Canada, on this 2nd day of April 2004
Paris, J.